Wednesday, April 23, 2014

The California Court of Appeals, Second Appellate District, recently considered whether an acceleration clause in a note -- which was coupled with a provision for a high default rate of interest to apply after acceleration -- could be triggered after the note matured or otherwise became fully due and payable. The Court answered in the negative, concluding that after the note matured and was fully due and payable, there was nothing to accelerate.

The plaintiff, a non-profit corporation (the "corporation") entered into negotiations to sell a community center to the Defendant, Hyman Levy ("Levy"). Levy deposited $2.7 million into an escrow account to demonstrate his interest in the property. When it became clear that the negotiations would take some time, that $2.7 million was converted to a loan to the corporation, secured by a deed of trust on the subject property.

The salient terms of the agreement between the corporation and Levy were as follows: (1) the corporation agreed to pay Levy the full amount of the principal, plus all applicable interest, by September 30, 2006; (2) Levy had the right to declare the full amount immediately due and payable upon the corporation's failure to make a required payment; and (3) if Levy chose to declare the full amount of the loan due and payable, interest would accrue thereafter at the highest rate permitted under applicable state law.

When the promissory note matured, the parties continued to negotiate the terms of a potential sale. The corporation did not pay off the note, and Levy did not demand repayment. After those negotiations broke down, Levy demanded repayment of the note. The corporation located another buyer, and informed Levy that it expected to pay off the loan shortly. Levy filed a Notice of Default, wherein he stated that the outstanding debt was more than $3 million. Levy's payoff demand was calculated on the basis that the corporation owed interest under the highest legal rate permitted, beginning on the day after the loan matured.

The corporation disagreed, but paid the requested amount under protest. It then sued Levy, asserting causes of action for breach of contract and money had a received. The corporation argued, among other things, that Levy could not charge interest at the maximum applicable rate because he did not declare the entire obligation immediately due and payable.

Prior to the trial, Levy filed a motion in limine, attempting to exclude the introduction of documents other than the note, and testimony regarding the conduct of the parties. He argued that the terms of the note were unambiguous, and should control the outcome of the litigation. The corporation agreed that the note was unambiguous, but nevertheless argued that it be allowed to introduce extrinsic evidence to support its interpretation of the note --specifically, draft purchase agreements which provided that the corporation owed less than was subsequently claimed by Levy, and at a lower interest rate.

The lower court ruled in Levy's favor as to the motion in limine, finding that extrinsic evidence was improper where both parties agreed that the terms of the note were unambiguous; and further ruled that the default interest rate --e.g., the highest permissible interest permitted under law -- was automatically triggered when the loan matured. The corporation appealed.

The Court began by affirming the lower court's decision to grant Levy's motion in limine, finding that it was appropriate given that both parties agreed that the terms of the note were unambiguous.

Next, the Court scrutinized the terms of the note to determine whether the default interest rate was triggered at the time the note matured. As discussed above, the note recited that upon the corporation's default and at Levy's option, "all sums owing hereunder shall, at once, become immediately due and payable. Thereafter, interest shall accrue at the maximum legal rate permitted..." Levy did not dispute that this language constituted an acceleration clause.

Under the circumstances here, however, the Court observed that "once the promissory note matured and the lump-sum payment...became due, the acceleration clause could not be triggered because there was nothing to accelerate."

Although Levy argued that the interest rate clause was separate and apart from the acceleration clause, the Court disagreed. It noted that "[t]he default interest language appears in the same paragraph as the acceleration clause and there is no indication in the note that this language relates to circumstances other than acceleration..." The Court also noted that noted that Levy, who drafted the note, could have included language providing that the default interest rate applied after the note matured, but did not do so.

Accordingly, the Court held that the application of the default interest rate was improper, and remanded the matter to the trial court to determine the appropriate amount owed by the corporation.

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